What The Fed’s Latest Move Means To You
May 10, 2023
What The Fed’s Latest Move Means To You
The Federal Reserve has raised interest rates for the 10th time since March 2022. This latest quarter-point hike has significant implications for consumers as Treasury yields rise causing overall lending rates to increase as well. The target federal funds rate was raised by 0.25 percentage points at the end of the Fed's two-day policy meeting, affecting borrowing costs for mortgages, credit cards, auto loans, personal loans, business loans, student loans, and the overall cost of credit for consumers and businesses alike.
While this latest rate increase marks the third consecutive hike of 25 basis points indicating a possible slowdown in rate hikes, this marks the quickest pace of tightening since the early 1980s; and has resulted in record high borrowing rates for consumers. Despite data indicating cooling inflation as a result of the Fed's super aggressive rate-hiking cycle, consumers should be aware of how these rate increases impact their finances and take appropriate action.
Even though the Fed signaled a pause may be near (no guarantees), this doesn't mean the Federal Reserve plans to halt interest rate hikes soon as the FOMC has consistently reaffirmed its commitment to achieving its 2% inflation goal and will closely monitor incoming information to assess its implications for monetary policy.
The committee will consider various factors, such as:
- Cumulative tightening of monetary policy
- Time lags between policy changes
- Economic activity
Economic and financial developments
These leading indicators will determine if additional policy firming is necessary. Additionally, as previously announced, the FOMC plans to continue selling off its holdings in:
- Treasury securities
- Agency debt
- Agency MBS
The Impact on Consumers
The Federal Funds Rate is the interest rate at which banks lend and borrow from each other overnight, set by the US central bank. While this rate does not directly affect what consumers pay, the Federal Reserve's actions do have an impact on the borrowing and saving rates they encounter daily, from everything to household items, to loans of all kinds.
When the Federal Reserve raises the Federal Funds Rate, it also increases the prime rate (+3%), which immediately raises financing costs for various forms of consumer borrowing. Conversely, higher interest rates benefit savers by increasing their deposit earnings, and while tending to offset any inflationary tax on savings, the overall higher cost of credit (or borrower money) tends to work against the consumer.
Here's how it works:
The Effects of Higher Rates on Your Finances
As most everyone knows, most credit cards have variable rates that move with the rate market. When the Fed raises interest rates, credit card rates go up; and when they lower rates, they fall. Depending on the overall health of the economy, and strength of the jobs market, consumers can find themselves with payment shock as higher than normal debt obligations that are suddenly impacted by rising rates.
When the Fed raises rates, and the prime rate increases, credit card rates tend to follow suit within one or two billing cycles, which can put further pressure on families and home buyer budgets. This increase in the cost of credit results in fewer home buyers in the market and demand drops.
Currently, credit card annual percentage rates are at an all-time high of over 20%, on average. As people face higher prices, more cardholders are carrying debt from month to month, instead of paying it off at the end of the month as is customary with many consumers. According to WalletHub, the latest .25 rate hike will result in an additional $1.7 billion in interest paid by card holders. The rate hikes between March 2022 and March 2023 will mean consumers pay an extra est. $31.7 billion in interest payments over the next 12 months.
The Fed's moves also negatively impacted homebuyer affordability cost of credit. Simply put, buyer affordability primarily gauges the consumers ability to get a mortgage with favorable terms, such as a low rate and low closing costs. As mortgage rates are mainly tied to the 15- and 30-year Treasury yields and the economy, rates are slightly off their recent peak of about 7.4% as the 30-year fixed-rate mortgage currently sits around 6.5%.
This rapid rate doubling over the past year has caused a lot of angst among homebuyers as they sit out the market and wait for rate to come down again. While this is the natural response to seeing rates quickly rise in a very short period of time, there’s no guarantee they’ll drop just as fast. Current Fed posture indicated a commitment to raising rates until a 2% inflation goal is met, or closely hit.
With home mortgages more closely linked to Treasuries and the Fed’s rate actions, other popular home lending products, such as adjustable-rate mortgages and home equity lines of credit (HELOC), are pegged to the prime rate which has pushed many HELOCs above 13% for the first time in years. And while homeowners still may have legitimate reasons for needing to access home equity, the long-term potential borrowing cost in a rate market that is still trending upwards should always be carefully considered.
While care loans are fixed rate loans–that tend to be simple-interest loans, the prices of all cars are rising with the overall market. This has pushed the average rate on a five year car loan to over 6.5%. Auto loan rates depend on various factors such as:
- Vehicle type
- Borrower credit score
- The time of year of purchase, and
- Down payment
And while these are factors the consumer very much controls, the Federal Reserve plays a very big role in determining where rates are, especially the Prime rate, when you buy a car.
When the Fed changes rates, banks and lenders change the rates they offer as well to reflect the new cost (higher or lower) to loan you the money. So, when the Fed raises interest rates, auto loan rates may also increase, and vice versa. Nonetheless, the Fed's rate is not directly linked to auto rates but rather tied to the prime rate, which again, indirectly impacts the rate you get for a car loan. Car buyers should also be aware of broader economic factors such as the chip shortage and overall inflation, which has caused the price for new and used vehicles to be extremely high in 2022 and 2023.
As Federal student loans are fixed, most borrowers aren’t immediately impacted by Fed policy and rate moves, but some private student loans are impacted, as they are variable rate loans meaning they move with the market. Such loans’ rates and payments are based on the Prime rate or Treasury bill rates, meaning as they go up, so do the loan payments.
CDs & Deposits
While the Fed doesn’t directly influence bank deposit rates or certificates of deposits, these rates tend to be correlated with changes to the federal funds rate (the Fed’s rate). Savings account rates at some large banks are currently up about .39%, while other high-yielding savings account rates are as high as 4.5% right now. Rates on a one-year CD at some online banks sits around 5%, according to DepositAccounts.com
Consumer Tips For Managing High Rates
Anytime rates climb, it’s always best to reduce your exposure to interest payments as best you can. Here are some strategies for managing your finances in a high-rate economy.
Pay down high-interest credit card debt.
Credit card debt tends to be the highest payable household loan, and because credit card companies typically compound interest daily and charge it monthly, carrying a balance month-to-month can become super expensive over time. Wouldn’t it be great to save a few hundred dollars every month instead of spending it on high interest rate credit cards? Proper debt management is key to being able to survive whatever unexpected event life throws at you, without going into debt to pay for it. To knock out your debt, make a place to pay it off. If you can’t pay it off, pay off as much as you can, then, cut up the cards and don’t use them anymore. The cards with the highest interest should be targeted for payoff or pay down first. But if you want to knock out the smaller ones first to get a small win and feel good, go ahead an do whatever works for you and your family.
Shop for a new high-yield savings account.
Rising rates can help you score higher APY on a savings account. Lot’s online banks offer CD yields around 5% right now and this is a very safe place to park your money if you’re cash heavy trying to avoid a certain, badly needed market correction.
Don’t make any sudden financial decisions.
Depending on how close you are to retirement can determine how risky you approach your financial decisions. Needless to say, the older you are, the less income runway you have ahead of you; and the riskier any downside potential has for a position. You have, after all, less time to recoup a loss than a younger person, so be smart. Changes in interest rates can cause positive or negative swings in your portfolio, causing you to possibly make a decision you otherwise would not have made in a less-volatile economy.
Avoid panic-selling on any position. If you believe as much as Warren Buffet does in the American economy, downturns aren’t the time to sell, they’re the time to buy. As he famously said, “The stock market is the only place where customers run out of the store when things go on sale.” As one of the wealthiest men in history said, the time to buy is where there’s blood in the streets–even if it’s yours. Fortunes–and companies I might add–find their origins made in bear markets. Investing should always be a long-term goal, so patiently ride out any short-term bumpiness.
Work on improving your credit.
Credit takes time to build, especially if you’re rebuilding it. So, it makes sense to do this when rates are high so you can take advantage of them when they drop with the best credit you can. Better credit = better rates and payments on everything, not just loans. To improve your credit score, pay your bills in full and on time each month; and don’t carry too much debt. Don’t charge more than 30% of the available balance on any of the cards or loans. Be sure to get a free copy of your credit report (it's very important to get copies from all three bureaus) and dispute any errors you find on it. You can dispute inaccurate information easily on the credit bureau’s website for free.
Upcoming: The Consumer Price Index (CPI) report comes out today, and after steadily declining for almost a year, date on consumer prices to be released Wednesday will most likely show inflation remains problematically high for the Fed and their beloved 2% target for inflation.
According to The Balance, The Consumer Price Index, or CPI, or a monthly measurement of U.S. prices for household goods and services. It reports inflation (rising prices) and deflation (falling prices). Both can hurt a healthy economy.
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